US issues Toxic Debt penalties to Credit Suisse & Deutsche bank

December 24, 2016 – Credit Suisse Group is a Swiss financial services provider. They provide banking, investment, and asset management services worldwide. The group was founded by Alfred Escher in 1856. Today, Credit Suisse Group has nearly one trillion dollars’ worth of assets under its management. The other institution that US Justice Department has hit by a penalty is Deutsche bank. It is a German bank that provides different types of financial services in more than 65 countries. Founded in 1870, it is one of the oldest banks in the world. The value of total assets under their management is near two billions US dollars; their annual operating income is in negative territory, though.

In a deal with U.S. Department of Justice, Credit Suisse has agreed to ~$5 billion fine. Credit Suisse has received this penalty amid selling toxic MBS [mortgage backed securities] to investors by misrepresenting the MBSs as being good. In other deal, Deutsche Bank agreed to pay a ~$7 billion fine; U.S. Department of Justice gave them a penalty for the same reason i.e. selling toxic MBSs.

Why did the U.S. Department of Justice give these institutions this penalty?

Credit Suisse and the Deutsche Bank received this penalty because they were doing some shady business, namely selling toxic MBS. To understand what toxic mortgage backed securities are, you first need to understand what a toxic-debt or toxic-loan is.

Toxic Debt

To grow business and to make more money, banks in USA and other developed countries were [and still are] giving loans/mortgages to just about only homebuyer who applies for one. Banks should have strict background checks and follow standard procedures before giving borrowers money to buy homes. They should make sure that the borrower has good credit rating and that he or she is earning enough money from a stable job, so he can easily pay back the loan with interest. But banks foolishly ignore these things and they hand over money to anyone who applied for a loan. Banks were following this business plan aggressively before the 2007/2008 crisis; banks thought that giving loans to people who probably cannot return it is not dangerous as they are covered by the property that the borrower is buying from their money. This business plan was working fine as the housing market was growing very fast before 2007/2008. During the 07/08 recession, hundreds of thousands of people lost their jobs. Banks stopped receiving mortgage payments and because the housing market has crashed, they couldn’t recover their money by selling the borrower’s home.

So, a toxic debt is a loan or mortgage that has very little chance of being recovered. The probability of borrower paying it back is very low and the property purchased from this loan is now worthless or cannot be sold to recover the principal amount plus the interest on the loan.

Banks have been making tons of money by selling Mortgage Backed Securities; these are bonds that usually have higher return on maturity. Big banks sell these bonds to other smaller banks, institutions, or even individual investors. These parties buy these bonds because the return on them is much higher than other bonds. Big banks are known to mislead investors into believing that the risk in these bonds is very low, where in reality it is much higher. They get BBB+ or similar high ratings for their bonds. When a MBS is comprised of toxic loans, it makes the MBS toxic too. These bonds are worthless; anyone who buys them gets no profit; in fact, they lose their money too!

So basically, Credit Suisse and the Deutsche Bank got this well-deserved penalty for selling toxic MBS to investors by misleading them into believing that they are buying safe MBS with little or no risk.